The fund manager warns against politically sensitive sectors

Maple-Brown Abbott’s Phillip Hudak outlined the smart plays being played in a small part of the Australian market, including warning against exposure to sectors that are “in the policy firing line”.

Speaking at the Morningstar Investment Conference 2024 in Sydney, he explained that the cost of living has become a significant issue in the economy and its impact continues to influence portfolio decisions.

“We see a huge difference between older demographics and younger demographics. You want to connect with consumers associated with an older demographic, so when it comes to travel, brick-and-mortar operators like Flight Center are great examples,” Hudak said.

But on the other hand, companies like Baby Bunting that are “deep in the mortgage belt” are facing challenging times from a margin and revenue perspective, said portfolio manager of Australian Small Business Fund Maple-Brown Abbott.

Hudak believes the fight to address cost of living pressures also extends to supermarkets, which have recently come under regulatory scrutiny over price gouging and competition concerns.

In February, the Australian government announced it would commission the Australian Competition and Consumer Commission (ACCC) to conduct an inquiry into the sector, the first of its kind since 2008.

The same month, an investigation led by former ACCC chairman Allan Fels into price gouging and unfair pricing practices in Australia also singled out supermarkets, identifying the Australian food and grocery sector as one of the most concentrated in the world.

Importantly, the report highlights that the average profit margin in this sector has remained remarkably stable despite the enormous price volatility across the domestic economy over the past few years.

“Unlike much of the retail sector, supermarkets have generally benefited from their position during and after the Covid-19 pandemic,” it said.

“Neither Coles nor Woolworths have seen a decline in profits or revenues during the pandemic as their core businesses were rightly deemed essential services. This position enabled business continuity and allowed us to maintain our position on the market.”

Hudak also observed that sectors such as Australian supermarkets are “in the policy firing line”.

“You have seen recently that supermarkets have been in the firing line. There is the potential for the NDIS to also start to come into the firing line given the cost increases,” he told listeners.

To combat this, he said the fund prefers to focus on sectors where the government is subsidizing part of upcoming wage increases, such as elder care and child care.

He predicts wages will be a major issue going forward and believes markets continue to underestimate the coming impact of wage inflation.

As of March 2024, the Australian Bureau of Statistics’ seasonally adjusted wage price index has increased by 4.1% over the year.

“I believe the market is underestimating the wage inflation that is expected to occur over the next few years,” Hudak noted.

“It’s quite interesting that we’ve never seen a wider dispersion between CPI and wages, which means real wages have been falling over the last few years.”

He partly attributed this to the “rigidity” of Australia’s employment system, with the Fair Work Commission setting the minimum wage annually, while business contracts are typically for periods of three to four years, suggesting a lag.

Hudak cautioned: “We may be in an environment where consumer price inflation is declining, but wage inflation remains relatively high. So the sectors we want to avoid are those that have a large employee base and minimal pricing power.”

In some healthcare sectors, including pathology and radiology, margins are tight “because indexation is delayed or prices have failed to increase,” he said.

Instead, Hudak said the fund was looking at solutions like in vitro fertilization, which were able to raise prices and keep margins high.

“The other area that we think will be difficult is retail. As sales are slow and the cost of doing business as a percentage of sales increases, we will see margins squeeze. How do we play it? We want to be associated with those companies that plan automatic price increases,” he said.

These include IT companies such as TechnologyOne and Hansen Technologies, which have CPI+ clauses that apply every year.

“(They) maintain these margins, as does insurance broker AUB, which is tied to some pretty significant increases in premium rates,” he said.